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Economy & Rates 5/7/2020 1

New reference points

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Bruno Cavalier
Chief Economist at ODDO BHF

  • We are starting to get our bearings in the lockdown regimes that almost all countries have imposed on their productive systems to limit peoples’ movements to the bare essential and, in so doing, to stem or slow the spread of the coronavirus. These bearings fall within a quite different reference point from what we are familiar with. In an ordinary recession, the level of activity drops by a few percentage points over several quarters. This time, production has plunged almost overnight by between 15% and 35%, depending on the country. In an ordinary recession, job destructions in a country such as the US amount to 3% of the labour force, also staggered over several quarters. In a long and severe recession such as the one in 2008-2009, this figure exceeded 6%. In the present recession, they have reached around 15% in a matter of just a few weeks. We could easily offer more examples. Banal as it is to say so, the reality is that this shock is unprecedented (see page 4). This obliges us to show humility when trying to predict what comes next, namely the lifting of lockdown measures.
  • The lockdown was sudden. The decontainment period will be gradual. Distancing measures will persist for some time, and obviously no-one can be sure that there will not be another lockdown in case of a second wave. The re-opening of production and trade facilities will be reflected in a sharp recovery in production and consumption. We have seen this in China over recent weeks, and it will be the same story elsewhere. Given how depressed they are today, it is hard to imagine that consumer and business confidence indices can go any lower. April may well have been the “worst” month of this crisis. What follows will not be as bad, but this does not mean that the shock will be reversed rapidly. Firstly, it takes time and money to restart the economy. Secondly, the shock, as brief as it may be, is of such magnitude that it will cause lasting damage to production factors (rise in unemployment and bankruptcies) and productivity. Lastly, until a large-scale treatment of the Covid19 exists, the degree of uncertainty will remain higher than normal, leading to postponements of consumer and investment spending. In all cases, recovery profiles will be shaped in large part by the conditions of decontainment plans (see pages 13-17).
  • The only truly reassuring point is that the economic policy response, in particular by central banks, appears proportional to the severity of the shock. By ensuring that financial institutions do not lack liquidity and that the real economy does not suffer from a credit crunch, they are preventing a financial crisis from adding to the health crisis and the economic crisis (see pages 18-23).
  • The current crisis has raised – or, more precisely, revived – a few key questions about the future functioning of the world economy (see pages 24-29). One relates to the cost of the crisis or, put differently, the rise in public debt. On average in developed countries, debt/GDP ratios are set to climb by around 20pts. The solvency of states depends less on the level of debt than on the rate at which it can be refinanced. This is why central banks can be expected to prolong, more or less explicitly, the monetisation and the control of yield curves. A second question relates to the inflation regime that will emerge from this crisis. After a long disinflation phase (post-1980) and another phase of deflationary concerns (post-2008), some have argued that inflation will start rising again. This thesis, constantly contradicted by the facts over the past decade, reflects a misunderstanding of monetary policies. It overlooks the fact that money creation does not lead to runaway inflation when underemployment is so massive. In reality, the present shock is fundamentally deflationary. Another problem relates to globalisation. The present crisis, some armchair futurologists predict, will lead to a relocation of all production and sound the death knell of complex value chains. Unless the capacity for trade is constrained by some authoritarian hand in a sort of permanent semi-lockdown regime, it is hard to see why there would be a collective repudiation of the benefits of free trade (lower costs, more efficient production and extension of markets). That said, the global economy’s dependence on China – one of the most visible facets of globalisation over the past 20 years – is likely to be called into question. Besides the fundamental reasons for criticising China, such as restricted access to its domestic market, non-compliance with competition rules and opacity, there are other more political ones. As November elections approach in the US, President Trump will probably step up his criticisms of China so he can pose as the protector of the American people. The trade war, which was the focus of so much attention since 2018 before being overshadowed by the coronavirus, can therefore be expected to stage a resurgence in the months ahead. Health-related uncertainty will recede, or so we hope, but economic, financial and political uncertainty is not over yet.

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